What is Bharat Bond ETF? Should you invest?

In the first week of December 2019, the Government paved the way for the launch of Bharat Bond ETF. The Bharat Bond ETF will invest in bonds issued by various public sector units.

From the investors’ perspective, it is a new investment option in the fixed income space. The Bharat Bond ETF is an easy and low-cost way to invest in bonds from public sector entities. From the Government’s perspective, it gives the public sector units a new source of funds and perhaps also help deepen bond markets in India.

What are the salient features of this bond ETF? Where does this ETF invest? What are the pros and cons? How will the income from the Bharat Bond ETF be taxed? Should you invest in Bharat Bond ETFs?

Before we dig deeper into Bharat Bond ETFs, let’s quick touch upon ETFs and Bond ETFs.

What are Bond ETFs?

An ETF (Exchange-Traded Fund) is a passive mutual fund that tracks and replicates an index. For instance, in the equity space, we have Nifty ETFs and Nifty Next 50 ETFs.

When you invest in ETFs, you get units just as you do in case of mutual funds. The ETFs, as the name suggests, trade on the stock exchanges. You can trade in ETFs throughout the day.

ETFs provide diversification with a single investment and a limited amount of capital and at a low cost. For a primer on ETFs, refer to this post.

A bond ETF tracks and tries to replicate the performance of a bond index.

Here is a good video on Bond ETFs from Edelweiss AMC.

What is Bharat Bond ETF?

1. This is India’s corporate Bond ETF. We have a few gilt ETFs in the market but nothing in the corporate bond space.
2. The Bharat Bond ETF is a target maturity Bond ETF i.e. it combines the features of a bond (maturity) with diversification benefits of an ETF. Here is a short video on Target Maturity Bond ETFs by Edelweiss AMC.

1. There are two ETFs, one maturing in 3 years and another maturing in 10 years.
2. The interest from the underlying bonds will be re-invested and not paid to the investors.
3. On maturity, the funds will be credited to the investor’s bank account.
4. The 3-year and 10-year ETF will track Nifty Bharat Bond Index-April 2023 (3-year ETF) and Nifty Bharat Bond Index-2030 (10-year ETF) respectively.
5. The ETF will invest in Government-backed companies.
6. The ETF will be listed on the stock exchanges for trading. Therefore, you don’t have to hold the bonds until maturity. You can exit on the secondary market if the liquidity permits.
7. The minimum investment is Rs 1,000.
8. The maximum investment for retail investors is Rs 2 lacs. If you invest more than Rs 2 lacs, your application will be counted under non-retail category.
9. The expense ratio of Bharat Bond ETF is 0.0005%.
10. You will need a demat account to invest in the Bharat Bond ETF.
11. If you don’t have a demat account and don’t want to open one, you will have a Fund-of-Funds (FoF) option from the AMC. The FoF will invest in the Bharat Bond ETF. However, the expense ratio of FoF will be an additional burden. The AMC has suggested that the expense ratio of the FoF will be less than 0.05%.
12. There is no lock-in period. You can sell as soon as the bond ETFs are listed on the stock exchanges.
13. Non-resident Indians (NRIs) can invest in Bharat Bond ETF.
14. The issue size of the 3-year Bharat Bond ETF is Rs 3,000 crores (with an option to extend it by Rs 2,000 crores.
15. The issue size of the 10-year Bharat Bond ETF is Rs 4,000 crores (with an option to extend it by Rs 6,000 crores.
16. Edelweiss AMC is managing the issue.

Where will Bharat Bond ETF invest?

The ETF will track the Bharat bond indices as mentioned above.

I am copying the index constituent break-up below.

As you can see, all the issuers are public sector units and are backed by the Government. This almost eliminates the credit risk in the ETF. All the entities are AAA rated.

The ETFs will invest in bonds that mature before the ETF matures, eliminating the interest rate risk for investors investing to hold till maturity.

What are the expected returns from Bharat Bond ETF?

The returns are not guaranteed (assured).

The bond ETFs will track the performance of the underlying indices i.e. Nifty Bharat Bond Index-April 2023 (3-year ETF) and Nifty Bharat Bond Index-2030 (10-year ETF).

The indicative yield of Nifty Bharat Bond Index-April 2023 is 6.69% p.a.

The indicative yield of Nifty Bharat Bond Index-April 2030 is 7.58% p.a.

You should expect returns in the similar range.

Do note these are indicative yields of the index. Your returns on ETF will be slightly different for the following reasons.

1. The expense ratio of the ETF or the FoF. However, since the expense ratios are very low, this won’t affect the returns much.
2. The Bharat Bond ETF will re-invest the interest income from the underlying bonds. You can’t be sure of the rates at which this interest from underlying bonds will be re-invested.
3. If the underlying bond matures before ETF maturity, the ETF will have to re-invest the money. Can’t be sure of the re-investment rate.
4. There can be an additional tracking error for various reasons.

The above points are applicable more to the Hold-till-maturity investor. If you want to trade in these bond ETFs or exit before maturity, your return experience can be very different due to the price volatility (due to interest rate risk).

How to invest in Bharat Bond ETF?

If you want to invest in the ETF, you can apply through your broker during the NFO period. NFO will be open from December 12^th till December 20^th, 2019. Subsequently, once the ETFs lists on the stock exchange, you can also buy from the secondary market.

If you want to invest in FoF, you can apply through your distributor (regular plan) or directly from Bharat Bond website.

Check the FAQs on Bharat Bond ETF website for more details.

What are the pros?

#1 Low expense ratio: The ETF has an expense ratio of 0.0005%. This is way cheaper than the cheapest of debt mutual funds.

#2 Safety (Low Credit Risk): Since these are Government-backed entities, there is very low probability of default on any of these bonds. If you constantly worry about your debt mutual fund portfolio, Bharat Bond ETF could be a good alternative.

#3 Transparency: Since the ETF will track an index, you do not have to worry about the fund manager risk. Recently, the investment decisions of many AMCs in the debt fund space have been called into question. The portfolio will be available on a daily basis.

What are the cons?

#1 Liquidity: In a mutual fund where you can redeem units with the mutual fund company whenever you want. In an ETF, you can’t do that. If you want to exit before maturity, you must sell the bond on the stock exchanges. For that to happen, there must be enough liquidity in the counter. In the absence of enough liquidity, the bid-ask spread can be very high and eat into your returns. You can’t be sure if the AMC will provide market-making services in the bond ETF.

#2 Interest Rate Risk: Even though there is limited credit risk in these bonds, the underlying investments (especially the 10-year ETF) are long maturity bonds from the PSU. Hence, the interest rate risk is still there. Remember the interest rate and the bond prices are inversely related. When the interest rates go up, the bond prices go down. When the interest rates go down, the bond prices go up. And the extent of ups and downs depend on the duration (maturity) of the bonds. Longer the maturity, the higher the sensitivity.

At the same time, since these ETFs are target maturity bond ETFs, the interest rate risk will go down with time (as the maturity of the underlying bond decreases). A bond ETFs that matures in 10 years today will mature in 7 years after 3 years.

In fact, this is a major difference between debt mutual funds and this type of ETFs. In a debt mutual fund, the fund manager will strive to maintain the duration profile of the portfolio as per the fund mandate. For instance, for medium-to-long duration fund, the fund manager will maintain the portfolio duration between 4 to 7 years. Even after 5 years, the duration will be the same as the fund manager keeps replacing the bonds to maintain the duration (maturity) profile. In the target maturity bond ETFs, the maturity (duration of the portfolio) and hence the interest rate risk will reduce with time.

Moreover, if you are a hold-till-maturity investor and can ignore the price movements, you don’t have to worry about the interest rate risk.

How will the income from Bharat Bond ETF be taxed?

As mentioned earlier, investors will not receive any interest payment from the Bharat Bond ETF. The interest from the underlying bonds will be re-invested by the ETF. Since there is no interest income, there is no question of this income being taxed.

If you sell the bonds before completion of three years, the resulting capital gains will be treated as short term capital gains and taxed at your slab rate.

If you sell the bonds after completion of three years. The resulting capital gains will be treated as long term capital gains and will be taxed at 20% after indexation.

An interesting (and smart) thing to note is that the 3-year ETF and 10-year ETF mature in April 2023 and April 2030 respectively. For a hold-till-maturity investor, this will provide an additional year of indexation benefit. Since the NFO period is from December 12-December 2019, this means the bond ETF will mature in a little over 3 and 10 years.

Should you invest in Bharat Bond ETF?

In my opinion, Bharat Bond ETF is a good option to have.

If you are looking for a safe fixed-income investment product, this could be a fine investment for you. However, you must be a hold-till-maturity investor in these bonds and can ignore price movements. For long term portfolios, you can consider this product for the debt portion of the portfolio. You can think of it as a cumulative fixed deposit (not a bank fixed deposit), where you deposit the money and get your money back with interest on maturity.

There is no interest income from these ETFs. Therefore, this ETF won’t suit investors who are looking for regular income from an investment. However, there is a Fund-of-Fund option. From what I understand, the FoF will be open-ended (Not exactly that but all you need is that it is not closed-ended i.e. Fresh subscriptions may not be allowed but you should be able to redeem with the AMC). Therefore, in order to generate income, you can invest in the FoF and start a SWP from the FoF. However, the price volatility due to interest rate risk can create problems. Remember, in case of a SWP, the rupee cost averaging works in the reverse. Hence, you are advised not to run SWP from a volatile asset

By the way, this shouldn’t be the end of Bharat Bond ETFs. If the issue is successful (and will likely be), you can expect many such ETF issues in the future. With time, you will have bond ETFs of various maturities available in the markets. For instance, bond ETF with 3-year maturity launched today has 3 years left to maturity. After a year, the same bond ETF will have 2 years left to maturity. Therefore, you will have options to invest in Bond ETFs that match your investment horizon.

In my opinion, Bharat Bond ETF or FoF is a fine product and can find a place in many portfolios.

What do you think?

Additional Links

Bharat Bond ETF website

FAQs about Bharat Bond ETF from Edelweiss AMC